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Reaction to Fed may surprise

08-29-2011 15:35 BJT

Markets often show perverse and unexpected behavior. There are times when the market anticipates bad news about a stock. When the bad news is announced, the price rises because the news is not as bad as anticipated. At other times the market anticipates a good profit results, and when it is announced, the price falls. The profit may not have been as high as expected, so it's seen as a poor performance.

Just how markets will react and assess the results of the Jackson Hole economic get-together on Friday will not be definitely known until they open on Monday in the United States time. Markets in Asia, which start trading Monday before trading begins in the US, will capture the initial expected reaction of the US markets, but it is only US market trading that will confirm the reaction.

It is widely expected that the Jackson Hole meeting will open the door to some form of fiscal stimulus, already dubbed QE3, for quantitative easing 3. This simply recognizes that the US is on the edge of recession - or according to some analysts, has already tipped into recession. The details of this strategy will be firmed up with President Obama's keynote speech on the economy in early September.

Our personal assessment of the Jackson Hole meeting is not as important as the market's assessment. The reaction may be perverse and unexpected. The S&P 500 index chart analysis provides a guide to how the market reacts to the Jackson Hole meeting.

We apply three analysis points to the S&P index. The first delivers a ho-hum result as the market waits for the details of the strategy in early September. The second sets some targets if the market believes Friday's outcome leads to more serious economic problems. The third sets some upside targets if the market believes the meeting was able to offer good solutions to the growing US economic problems.

These reactions will also feed quickly and directly through the currency markets, and these will provide a leading indication of how the S&P index might behave. The US Dollar Index and the Euro/Dollar are all poised with symmetrical triangle patterns. These patterns show indecision. The bearish forces - those who believe the Jackson Hole outcome is bad - are evenly balanced against the bullish forces - those who believe the outcome is good. Because they are symmetrical triangle patterns, the probability of an upside breakout is evenly balanced with the probability of a downside breakout. These breakouts have the ability to move rapidly and explosively in a breakout.

Lets start with the ho-hum result, which shows the market is waiting for more details of the policy. We would expect to see a retest of support near the 1130 level. This has two supporting features. First, this is the target for the measured downside move from the head and shoulder trend reversal pattern in the S&P index. It's a powerful target level because it is also the top of the trading band that developed between January 2010 and October.

A ho-hum result is a consolidation around this level. Consolidation occurs when the volatility of the bounces - the rallies and retreats - is reduced and stabilizes. This is an L-shaped type of recovery.

If the market believes the Jackson Hole results show a failure to act or to act enough, the S&P index will break below the support level. Here we look for the bedrock of historical support. There are two ways to determine this. The first is the lower edge of the trading band located near 1040. This is not a large fall, but neither is it the technical target calculated by doubling the initial head and shoulder target. In 2008, these double target projections were reached and exceeded. The double projection target level is around 1000. This level is not a historical support level.

At best, this suggests the potential to crash to 1000 but then rebound and consolidate around the 1040 level. Freefall below 1000 has the next historical support target near 900. This would indicate a severe recession and a long-term double dip. We need to see the nature of this fall below 1000 before the relevant behavior patterns can be extracted and this target confirmed.If the market believes the Jackson Hole results are a positive move forward, it will rebound on the prospect of some type of QE3. Asia will brace for a new flow of cheap, hot money.

Creating these policy directions is one step. Many believe the US political system has become so dysfunctional that it is exceptionally difficult to implement these policies. The S&P index chart confirms it is a hard slog back to the top. There are layers of overhead resistance that have to be broken. The first resistance level is near 1270. This projection of the neckline for the head and shoulder pattern. It is also near the value of the lower edge of the long term GMMA group of averages. This captures the activity of investors. When they join the selling, the trend is confirmed. The wide spread in the long term GMMA provides considerable resistance for any market recovery. Think of this as pushing through an airbag of resistance. The farther you penetrate, the stronger the resistance pressure. The upper edge of this is near 1280.

The head and shoulder pattern on the S&P index is shallow. The shoulders are nearly as high as the head, and some analysts have described this as a triple top pattern. We think the slightly higher head is significant. Either way, there is strong resistance near 1350 to 1370. It more difficult to go up than it is to go down.

Editor:Yang Jie |Source: China Daily

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